Worried about getting Social Security as promised? If you’re not, don’t read the next paragraph.
The Social Security Administration recently issued a message to the public summary The report of the trustees of the Social Security and Medicare trust funds. It stated: “The Old Age and Survivors Insurance Trust Fund (OASI) will be able to pay 100 percent of total scheduled benefits through 2033, one year earlier than reported last year. At that time, the fund’s reserves will be depleted and ongoing income from the program will be sufficient to pay 77 percent of scheduled benefits.”
If you think you have it bad, imagine what things look like for your children and your grandchildren. Will Social Security be around when they retire?
If you have come to the conclusion that you should not depend on the goodness of the government for your retirement and that of your descendants, congratulations, you have taken the first important step in protecting your family. Now you can move on to the next step and start doing something about it.
Have you started a 529 plan for your children? If so, there’s a new way to use it to save for retirement. You can read about it here. If you don’t want to wait for this decade-plus process to work, here’s something you can do right now. Can start an IRA for children for your children All it requires is that your children have income from work.
What is considered earned income for a child?
A children’s IRA is like an IRA that you would create yourself. The only difference is how it is configured. But it still requires that the IRA contributor (in this case, the child) receive employment income during any year in which the contributions are made. Believe it or not, this can be easier than it sounds.
“Earned income can be a paycheck from a regular job (not many young kids will have these), or it can be money a child has from self-employment,” says Andy Rosen, investment and tax spokesperson for NerdWallet. , based in Boston. “If you can hire your son to babysit, walk dogs or sell items online, he may be eligible to contribute to a ROTH IRA. Just keep in mind that child labor laws could limit the paid work your child can do.”
There may be more flexibility if you own a business (either full-time or as a sideline).
“A great scenario is the case where a parent operates a business that is reported on Schedule C of their tax return and their minor child is an employee,” says Robert Steinberg, founder and CEO of Blue Chip Partners. in Farmington Hills, Mich. “The child can receive wages and the parent is not required to withhold Social Security (FICA) or Medicare. Years ago, we had a client who owned his own business and hired his children to clean the building and do other odd jobs, like data entry. They were paid wages that were not subject to employment taxes and the children were able to open a ROTH IRA since they had wages. This special rule only works for Schedule C taxpayers and not for corporations.”
If I pay my child for chores, is that earned income?
Many parents pay an allowance to their children. This could be “payment” for doing chores or other activities that benefit the family. You may be wondering if this counts as income. Unfortunately, it is not.
“Income from chores is considered non-employment income,” says Alvin Carlos, managing partner at District Capital in Washington, DC.
Similarly, money received as a gift from any source cannot be counted toward the income requirement that determines how much can be contributed to a child’s IRA.
“You can’t use a gift of earned income for this purpose,” Rosen says. “The money has to come from work. So if you’re thinking of just writing your child a check and then using it for a ROTH IRA, you’re out of luck.”
What is the best retirement plan for children?
Minor children who have started their own businesses will often find it helpful to consider creating SEP-IRAs or so-called “Solo” 401ks. This is probably an option for enterprising teenagers. In general, however, the Standard IRA represents the best way to create an IRA for children.
Then it comes down to choosing between using a traditional tax-deferred IRA or an after-tax ROTH IRA. Given your child’s likely income levels, you will find that the ROTH option offers the greatest benefit.
“If your child earns less than the standard deduction ($12,950), your child will not owe any federal income tax on their earnings,” says C. Ryan Quinty, a financial adviser at Cyndeo Wealth Partners in Saint Petersburg, Florida. “In very low-income cases like this, it’s best to open a ROTH IRA.”
Even if your children have to pay taxes on their income, the benefit of deferring taxes today may not be enough to outweigh the advantages of withdrawing money tax-free in retirement.
“Assuming a low tax rate (not a Hollywood star), then a ROTH IRA makes the most sense,” says Steinberg. “The value of the tax deduction for a minor is likely to be small, but the benefits of lifetime tax-free accumulation are significant.”
At what age can I start a Roth IRA for my child?
How old should your child be before you start thinking about setting up a child IRA? You may be surprised to learn that there is no age limit.
“The minimum age to open an IRA is birth, as long as the child has earned income,” says Andrew Latham, director of content at SuperMoney.com in Santa Ana, California. “Of course, it is rare for young children to earn an income unless they are paid for the work they do as a model, actor or performer. The key to qualifying for an IRA is that it earns income, and that the income is earned through some form of work or service, rather than being gifted or inherited. The child must have earned income equal to or greater than the contribution amount to make a contribution.”
However, in all cases, you will need to sign the documents on behalf of your child. Minor children cannot enter into agreements, so an adult (ie, a parent or guardian) must act as custodian for these accounts.
“To set up a child IRA, connect with your bank or brokerage firm and follow their instructions for opening a custodial IRA,” says Kimberly Bridges, senior vice president and director of financial planning at BOK Financial.
Financial companies may use different names for these accounts. They might be called “Children’s IRAs,” “Minor IRAs,” or “Custodial IRAs.” They may also be simply called “IRA”. You will have to make it clear what you intend to do.
Guiding your children on the path to starting a children’s IRA will be their first step toward financial independence, no matter what happens with Social Security.